- PC fundamentals have improved due to strength in the core Ultrabook line-up.
- Printing segment will continue to struggle due to an environment of declining usage.
- However, HP Inc. stock is extremely cheap and patterns of value recovery are starting to materialize.
I’ve liked HP INC (NYSE:HPQ) for quite a while now, but there are some near-term pitfalls to owning the HP Inc stock as investors have fled PC OEMs for quite a while as it’s become more difficult to sustain margins in an environment of declining PC shipments. While Intel believes we’re on the cusp of a major PC refresh cycle, there’s little evidence to suggest that those near-term tailwinds will become a material factor for sales in the just concluded quarter.
Analysts are anticipating HP Inc. to report Q1 2016 earnings of $.36 per share, and revenue of $12.2 billion. Over the near-term, revenue from the printing segment is expected to disappoint, whereas holiday quarter sales could prove to be better than expected due in part to HP Inc’s re-emerging presence in the UltraBook category due to the Spectre X360 series, which received solid reviews and ratings from a plethora of tech magazines. I believe UltraBooks and high-end laptops will remain a growth category for HP Inc. The company reported in Q4’15 that desktop revenue declined by 10% whereas Laptop revenue grew by 10% y/y.
However, printer margins will likely struggle in this environment as HP Inc. positioned itself at the low-end, in which ink usage is low. Low-end printer units are also less profitable. HP Inc. mentions that they’re introducing some additional programs to increase printer ink usage, but in a world where Adobe Reader and Verisign exists, the usage of paper and ink will continue to decline. HPQ Inc. is in harvest mode with the printer business and efforts to reignite growth may bear fruit in the form of 3D Printers. However, I’m somewhat skeptical of HP Inc’s efforts to sustain its top line growth rate. There’s no evidence to suggest that printing will recover or that it can successfully penetrate into the 3D Printing space as it has no cost leverage or product advantage when compared to newer entrants like Carbon3D.
For the PC segment to mitigate declines, the sales mix will need to shift to higher-end PC units. Unfortunately, Hewlett-Packard’s presence in the high-end isn’t very convincing with the exception of its Spectre X360 line-up which is priced at $1,000 to $1,400, which is the sweet spot for high-end Laptop pricing. However, HP Inc. isn’t known as a high-end desktop brand, as many have either opted for the iMac or custom built PCs, which leaves the unattractive and highly competitive low-end desktop market to HP Inc. The company reported a 10%-unit decline in desktops, which translated into a 14% y/y decline in revenue for that category in Q4 2015. The unit decline seems concentrated in the more expensive SKUs, which implies ASP erosion. I’m anticipating these trends to continue due to structural market factors.Source: IDC World Tracker
Emerging market growth hasn’t really materialized as many EM consumers have leapfrogged past PCs and have opted for content consumption devices (Android smartphones and tablets). The sub $400 category has been a dead zone in the emerging markets, which has prompted Intel to design USBs that have built-in mobile SoCs on Atom architecture, which can be plugged into the USB port of a computer monitor as an alternative to the conventional X86 ATX configuration. The problem with this approach is that it diminishes the market for tower PCs, as tower PCs can’t really compete with $100 plug and play devices, and the lack of productivity software for low-end PCs diminishes the use case to Microsoft Office Suite. As such, the PC market has declined by 10.6% on aggregate.
If consumers want advanced photo/video editing software, Auto CAD, software compilers it then makes sense to purchase a desktop PC that costs above $1,000. However, HP’s presence within the high-end has been near non-existent, and from my own personal experience I haven’t seen any of the major consumer electronics retailers market high-end tower PCs. Typically to purchase these PCs you will have to buy direct from either Apple or Dell. As such, investors should anticipate HP Inc’s efforts in PCs to yield low single-digit growth due to its presence in laptop and Ultrabooks. However, competition from Chinese OEMs limits upside to HP Inc’s laptop business.
Doing some back of the napkin math, I anticipate printer revenue to decline by 5% per year over the next five-years, PCs to sustain low single digit growth, and software revenue to also decline by 5% per year. In other words, HP will remain stagnant, and may generate some growth through cyclical periods where PC upgrades are heightened. A major upgrade cycle may materialize within the next one to two years but beyond that point, HP Inc. will need to penetrate into new consumer electronics categories or expand its efforts in software. It’s not yet clear if HP Inc. will converge on software to a meaningful extent as the company has used its free cash flow for share repurchases. Therefore, the company’s growth prospects are dim. Sure, HP Inc. has gained some market share in the past year, so the company’s efforts in branding and marketing are generating some modest results.
However, investors should realize that the only argument for buying HP Inc. stock is due to its 12-month forward P/E of 6.9. I think the stock is somewhat undervalued and I anticipate that it will at least meet consensus estimates for FY’16 due to its established presence in high-end laptops. Therefore, I value the business at $11.80, which implies a 14.3% upside from current levels. Since it’s intrinsically undervalued and many of the risk factors cited in this article are built into the current valuation, I could see the HP Inc. stock moving modestly higher throughout the year.